YARDENI: Stocks And Home Prices Are Right At Fair Value

In a
speech last Thursday, Governor Jerome Powell expressed some
concern that QE “might drive excessive risk-taking or create
bubbles in financial assets or housing.” He indicated that the
Fed’s staff is closely monitoring valuation metrics in various
asset markets.

Regarding the stock market, he said: “By most measures, equity
valuations seem to be within a normal range. Whether one looks at
trailing or forward price-to-earnings ratios, equity risk
premiums, or option prices, there is little basis for arguing
that markets show excessive optimism about future returns. Of
course, in the equity markets there is always downside risk.” I
tend to focus on forward P/Es, which suggest that stocks are
neither cheap nor expensive.

As for home prices, Powell said that the Fed's staff tracks a
model that compares them to rents. I tried to duplicate it by
dividing the median existing home price by the tenant rent
component of the CPI. My results come close to Powell’s statement
on this subject: “At the peak of the bubble, house prices were
more than 40 percent above their usual relationship to rents,
according to one model that the Fed staff follows. At their
trough, house prices had fallen about 10 percent below fair
valuation. Given the price increases over the past year, they
are--by the lights of this one model--moving back into the
approximate neighborhood of fair valuation.”

On the other hand, Powell was concerned about excesses in the
credit markets. He mentioned Governor Jeremy Stein’s speech
on this issue earlier this year. He added, “These concerns have
diminished somewhat as rates have risen since mid-May.”